Chart Reading 101

Today we’re going back to charts (and many readers will undoubtedly saying “hurray!”).  We typically avoid using too many charts because most traders don’t need any reinforcement on this end. Traders are typically chart junkies, to the detriment of fundamental analysis, sentiment analysis, risk management , position sizing and…common sense.

But today we’re going back to charts in order to offer a clear structure that exemplifies simple, top-down timeframe useage in order to have a clear understanding of chart geography and current trends. This structure is useful for anyone, but especially for traders who cannot spend much time at their workstation due to their day jobs.

Welcome to Charting 101.

Top-Down Structure

All you need to know about charts is this:  they represent the past and only certain junctures are interesting for future reference. The key junctures that traders pay attention to are the zones that, in the (recent) past demonstrated some kind of orderflow imbalance.

These zones typically show up on our price charts as consolidations (fair value zones) or swing highs/lows. The fact is that most information that can be found on the web regarding imbalance zones, demand-supply zones or whatever name people have adopted, focuses on “fading” the zone – that means adopting the typical “reversal” mindset instead of the (more useful) continuation mindset.

In reality the zones are simply “decision levels” and the market may decide (based on current fundamental influences) to push through or reverse. Often this reaction can take time to work itself out, and once again most traders don’t possess the patience or the correct understanding of timeframes in order to understand what to expect.

Here is the structure we will be working with:

  • Weekly Imbalance Zones = places where the Daily chart might rotate and start a new Daily trend OR continue in line with the current Daily trend.
  • Daily Imbalance Zones =  places where the Hourly trends might rotate and start a new Hourly trend (which would be a Daily Retracement) OR continue in line with the current Daily Trend.
  • Hourly Imbalance Zones = places to trigger entries in line with the current Hourly Trend.

Colour Code:

  • Sea Green = Counter-Trend Reaction Zone
  • Orange = Daily Trend Violation Zone
  • Pink = Lower Key Swing Highs
  • Light Green = Daily Higher Low (counter-trend alert)

Start for example by plotting the areas where the market previously departed from in an evident way, on the Weekly Chart. You don’t need to go too far back in history to do this. If there are no areas in the past 3 years than just base yourself off the Daily chart reading (below).

From the top, in early Feb 2018, the Aussie fell through the most recent Daily swing low and fell all the way past January lows without printing a lower high. That means the potential counter-trend retracement can be impulsive. However the Daily trend remains well below the Orange zone and prices continue to fall away from the Jan/Feb highs printing lower highs and lower lows along the way.

The first counter-trend move was attempted in April after a higher low alert (light green) but prices remained well below the March highs and the trend eventually fell back into place.

May was the next counter-trend move which plotted 2 higher lows and thus really threatening the trend. This wasn’t surprizing given the location: we had reached the previous Weekly imbalance zone. The zone didn’t really prove to be strong and during May we already pushed through it (hence it was losing significance) but if there was a place for the Daily chart to rotate, this location made sense.

With more or less the same dynamics, the trend continues to this day.

Using the Hourly Trend for Entries

Moving onto the hourly chart, we’re going to start monitoring the Hourly Trend after the Daily Trend Violation (Orange) in February 2018.

The key is to visualize the hourly trend just like the daily trend: monitor the imbalance zones in favour of the current trend (pink) and against the current trend (sea green). It should be evident that the hourly chart provides a multitude of opportunities to enter into a Daily trend, if you know where to look.

  • The most recent swing high should hold the market down
  • A counter-trend swing point should become resistance once broken.

Once one of these dynamics fails, you know something is up, and the (current) psychology of the market is changing. This happend on Feb 12th as the market failed to respect the most recent swing high and pushed through (X). From that moment onwards, the hourly trend started turning around and at that point we need to mark the evident counter-trend reaction levels (red circles) which need to be hurdled in order to turn the hourly trend back in line with the Daily.

Of course, the hourly trend might continue PAST a daily swing point, and at that point the Daily chart would kick into neutral or turn around.

In the chart above we’ve gone forward, showing what happened as the hourly chart started to push in line with it’s Daily trend again. It’s pretty much self-explanatory as the structure does not change.

And this brings us to our current situation on the Aussie. The most recent swing points on the hourly chart are being tested and the reaction has been rather weak today. This should raise a red flag as the market seems to be losing convinction and the hourly trend (which has been rangebound anyhow for the past 2 days) may be ready to turn around – even if temporarily – towards the previous weekly violation zone (0.7150/80).

Over to You

This simple structure will keep you on the right side of the market, if you maintain your focus and be disciplined not to trade every counter-trend hourly move. Too often that’s exactly what happens when traders are presented with the “magic” of previous imbalance zones: they go crazy trading anything independently from trendiness, fundamentals or common sense.

Once again, these levels offer clues about where other traders might re-engaging with the current trend or exiting with trailing stops. There is no certainty of course, and the levels are most effective when you’re trading in the direction of a broader trend.

The idea is to make your life extremely simple.

  • Plot the levels at which the Daily chart may encounter trouble (Weekly imbalance zones)
  • Via your preferred measure, establish the Daily Trend.
  • Zoom into your Hourly chart and plot the most recent imbalance levels in favour of the current trend.
  • Wait until price negotiates your hourly charts and trigger your entries based on your preferred tactic.

Then

  • Be alert for when the most recent hourly levels fail to hold. Most likely the market is entering a transition.
  • Be very clear on what constitutes a Daily trend change vs. Retracement.

If you can do this with discipline and be consistent, your trading should become more efficient, more effective, and offer stronger confidence.

Good Luck!

About the Author

Justin Paolini is a Forex trader and member of the team at  www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.

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